“Three-legged stool” is an old phrase that many financial planners once used to describe the three most common sources of retirement income: Social Security, employee pensions and personal savings. It was expected that these three together would provide a solid financial foundation for senior years. None of the three were expected to support most retirees on their own.
However, times have changed, and the three-legged stool has changed as well.
- “Three-legged stool” is an old term for a trio of common sources of retirement income: Social Security, pensions and personal savings.
- One leg of the stool, the pension, has been replaced by defined-contribution plans that put the investment burden on the individual.
- Another leg of the stool, Social Security, is looking dire, with predictions that the system could run out of reserves by early 2033.
a new foot for the stool
For young workers in the private sector, the pension leg has been mostly changed. Instead of a pension — aka a “defined-benefit plan,” which was funded by a combination of company and employee contributions — workers now have 401(k)s and other defined-contribution plans, called retirement savings. Also known as accounts.
Originally, these retirement savings plans were never meant to serve as a pension; They were to be supplementary savings accounts, forming the third stage of the stool. Yet, since the 1990s, employers have been systematically saving themselves money and financial responsibility by replacing guaranteed corporate pensions with these tax-advantaged plans. Some companies match employee contributions up to a certain percentage, but many don’t even offer assistance to that degree.
Traditional pensions, officially known as defined-benefit plans, guarantee a fixed amount of monthly income in retirement and place the investment and longevity risk on the plan provider. Defined-contribution plans, such as 401(k)s, place investment and longevity risks on individual employees, asking them to choose their own retirement investments with no guaranteed minimum or maximum return.
social security status
As for Social Security, the 2021 Social Security Board of Trustees annual report warned that Social Security trust funds could dry up within two decades at the current rate of production: “Old-Age and Survivors Insurance (OASI) Trust Funds, One who pays retirement and survivor benefits will be able to pay scheduled benefits on time until 2033… at which time, the fund’s reserves will be depleted and continued tax income will be enough to pay 76 percent of scheduled benefits “
Of course, the emphasis is on the hypothetical; It is still not fully known what the lasting effects of the COVID-19 pandemic will be. The estimates also don’t account for rising interest rates, increased revenue or many other factors. Finally, it is unlikely that the US government will allow a recession to happen without taking action.
Nevertheless, it is a date that is still a matter of concern. Workers in the United States can go online and review their Social Security accounts to see how much benefits they’ll receive at early retirement, full retirement, and age 70.
Personal savings for retirement remain low
This leaves our third step, personal savings. The savings rate for American workers has been extremely low over the past decade—the recession and stagnant wages have made it difficult to keep money aside. Still, with the rest of the stool looking staggering, individuals will need to start saving a substantial portion of their income and continue to use tax-advantaged retirement plans like IRAs and annuities to build their retirement nest eggs.
The percentage of your paycheck that financial advisors recommend investing in a retirement savings account on a regular basis.
Financial advisors recommend keeping at least one fifth of your annual earnings for retirement. The sooner you start, the better off you are to take advantage of compounding investment returns. At a minimum, advisors recommend that employers contribute enough to your 401(k) to maximize the match, if your employer offers one.
With pensions being replaced by retirement savings accounts, we’ve almost come down to a two-legged stool—not something you can really rest on safely. The government has debated possible solutions to Americans’ retirement-savings issues, including creating hybrid pension plans, national or state-level retirement savings plans for those who have no money to offer through their work, and Even the federal Thrift Savings Plan (a defined-contribution plan, currently available to government employees and those in uniformed service) is available to all Americans. It’s also weighing options for boosting Social Security, and making sure it doesn’t run out of funds.
In the meantime, it may help to think of tax-advantaged retirement plans as the second phase of the stool and work on building the third phase along with other savings, which include investments such as real estate. Or maybe we just need a new metaphor.